Is Paying For Discount Points To Get A Lower Mortgage A Good Idea?
Even when mortgage rates are low, homebuyers can take advantage of discount points. These optional prepayments of interest bump the rate even lower. But they aren’t for everyone. Homebuyers should research different lenders and carefully consider if this is a good option for them. It’s also vital to decide how much they are willing to invest. Buyers should ensure that shelling out more money at closing won’t cause undue financial harm against making their mortgage payment.
What Are Discount Points?
Typically discount points are 1% of the loan amount and lower the mortgage rate by 0.25%. So a $350,000 mortgage with a rate of 2.5% would, on average, cost $7,000 to buy two points to lower the rate to 2%. If you are itemizing tax deductions, these pre-payments can be claimed in the same year they are paid.
However, these are just estimated figures that can change from lender to lender. Shop for the best options and measure that against the potential discount. It’s also important to read the fine print of mortgage rates that seem atypically remarkable for the current market. The rate may only be available with points purchased. The lender must provide an official loan estimate document three days before closing. This document will list the points to be paid at closing with other costs and fees.
Break-Even Point
Homebuyers can determine if the points are worthwhile by assessing whether they’ll keep the mortgage past the break-even point (BEP). The BEP is achieved when the savings reach the amount the homebuyer paid out in points. After the BEP, the savings begin. If the homebuyer sells before reaching that point, the amount paid for the discount won’t break even and will result in some loss.
To determine the math, find out what your monthly payment will be without points. Then, calculate the monthly payments after the mortgage rate drops by buying points. Next, subtract the cheaper monthly amount from the base monthly amount. That difference is your monthly savings. Divide your prospective points purchase by the savings amount to see how long you’ll have to hold your mortgage to reach the BEP.
For example, a mortgage payment without points at 3% is $1,265 monthly. The homebuyer wants to purchase two points for a total of $7,000 on a $350,000 home. The interest subsequently drops from 3% to 2.5%. This rate drop lowers the monthly payment to $1,185, for a savings of $80 a month. The homebuyer divides the $7,000 point purchase by the monthly savings of $80. The result is the BEP will be reached in 87.5 months, or over seven years.
In this example, if the homebuyer plans to sell the house before that time, buying the points may not make sense. Conversely, suppose the homeowner has an influx of cash from the sale of the former home. In that case, it may still be advantageous to lower the rate, regardless of future plans to sell. The advantage would be lower monthly payment as the loan progresses, freeing money for other expenses on the monthly budget.